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ECONOMIC EVALUATION

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 EVALUATION OF PROJECT PROPOSALS

Everyone is impressed by the ingenuity shown by you in evaluating Proposals A and B from a macro perspective (Assignment #1). So much so, you have been invited, once again, for a further analysis of the two project proposals. The main objective of this analysis is to ascertain the financial and economic viabilities of the two proposals. The estimated capital cost of each of these proposals, you might recall, is $30 billion (bn). Other details are provided below.

PROPOSAL A

Financial

Proposal A envisages generation of electricity from water - a hydro-electric project. The

useful economic life of this project is estimated to be 60 years. This project will generate

50,000 million (mn) units of electricity annually. Electricity will be sold to the public at a

tariff of 8 cents per unit. The annual operation and maintenance costs are expected to

be 3.3 percent of the capital cost.

Economic (Social)

The economic (social) costs and benefits for this project must be estimated from

Figure 1.

PROPOSAL B

 

Financial

Proposal B is a thermal project - electricity will be generated from coal. The annual

operating costs for this project are estimated to be 8 percent of the capital cost. This

project will also have a useful economic life of 60 years. It will generate 45,000mn units

of electricity annually. The electricity from this project will be sold at 12 cents per unit.

Economic (Social)

The economic (social) costs and benefits for this project must be estimated from Figure 2.

Task

 

Your task is simply to present the results of your analysis in the answer-sheet provided separately.

Notes:

     You must provide the background details (i.e., select calculations), for various answers provided by you in the answer-sheet, in an Annexure (no more than two pages). You must type-write your Annexure. You must not attach any computer-printed spread-sheet in the Annexure. The minimum permissible font size for the Annexure is 12 (Times Roman or equivalent).

     The completed answer-sheet must however be a stand-alone document (i.e., the reader should be able to understand the entire logic behind your reasoning without needing to refer to the Annexure.

     There is no tolerance on specified word/page limits. Any written material beyond these limits will not be marked.

     Please tick (√) only one box wherever a multiple choice is provided.

Assumptions (common to both proposals)

      All capital costs are incurred at time t=0 (i.e., ignore project construction time).

      For financial evaluation, electricity generated, electricity tariffs, annual costs and the discount rates remain constant throughout the economic lives of the projects. For economic evaluation, these entities remain constant for the duration of each market structure (i.e., monopoly, oligopoly, and competition). 

      The economic (social) costs and benefits must be estimated exclusively from Figures 1 and 2. The costs and benefits represented in these figures are all inclusive, i.e., total costs include capital and operating costs and the demand curves reflect all benefits provided by the projects.

      For the purpose of estimation of economic (social) costs and benefits assume that the market structure for electricity sector is currently monopoly. It is expected to remain so for the first twenty years of the project life-span. The government however proposes to transform this market initially into an oligopoly (for the years 21 to 40) and eventually competitive (years 41-60). While it is difficult to precisely estimate the price and quantity outcomes that will prevail in an oligopoly market, the economic brains of the time have suggested that these outcomes are as shown by dotted lines in Figures 1 and 2.

      The real annual discount rate is 10 percent. Annual inflation is expected to be 5 percent and escalation (due to the scarcity of coal as fuel for electricity generation), 3 percent. Further, the economic and financial discount rates are assumed to be the same.

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